This one is again from one of Ben Bernanke’s (BB) speeches. It was given in 2004 but is very important. The subject is Great Moderation.
Over the years economists have documented that volatility of both, inflation and output have come down over the years. This development is termed as Great Moderation.And this has been a phenomenon in many countries. Earlier, there was a trade-off between the two i.e. either you could have lower volatility in output or lower volatility in inflation but not both. Hence, we hear this term so often in many Central Bank speeches.
What are the advantages of lower volatility. BB explains:
Lower volatility of inflation improves market functioning, makes economic planning easier, and reduces the resources devoted to hedging inflation risks.
Lower volatility of output tends to imply more stable employment and a reduction in the extent of economic uncertainty confronting households and firms. The reduction in the volatility of output is also closely associated with the fact that recessions have become less frequent and less severe.
What are the reasons for great moderation? BB says three borad reasons are identified by economists:
1) Structural Reasons: changes in economic institutions, technology, business practices, or other structural features of the economy have improved the ability of the economy to absorb shocks.
2) Improved Macro policies: particularly mon policy
3) None of the above or simply plain good luck.
No points for guessing but BB talks about role of Monetary Policy in achieving so called moderation.
Read the whole speech to get some ideas on the subject. As usual he goes back to history to identify the possible reasons why there was a trade-off (as policymakers believed in Philips curve) and explains the basics of moderation via a graph (Taylor curve). He then says why mon pol has an important role to play in understanding great moderation.
Update 1: I checked whether there is any kind of moderation happening in India as well. Here is a simple table (shows Standard deviation of annual % change):
1970-05 4.2 7.2
1970s 5.7 9.4
1980s 3 3 6.1
1990s 2.4 5.2
2000s 2.0 2.6
See that – there is moderation in India as well !!
Update 2:This is an excellent (very simple as well) paper on the above. It has an excellent cross-country analysis (of developed countries) and in all the moderation has shown to be present. He looks at the three factors cited as responsible for this moderation and finds Mon Pol and Structural Reasons to be the most plausible factors.